The Great Housing Supply Dilemma: Why Homeowners Are Hesitant to Sell

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The housing market is an enigma, with unique characteristics that set it apart from other markets. It can be described as a heterogeneous, thinly traded, illiquid market, meaning that it is diverse and features a wide variety of homes with varying ages and conditions, and sales occur infrequently. Additionally, the buyer is often also the seller, as the decision to sell one home is intrinsically linked to the decision to buy another.

From 2000 to the onset of the pandemic in 2020, existing-home inventory accounted for nearly 90% of total home inventory. However, the current state of the market is marked by a lack of supply rather than a lack of demand. The primary factor holding back the housing market is the reluctance of homeowners to sell in today's higher mortgage rate environment.

Low mortgage rates during the pandemic created a sort of "golden handcuffs" for homeowners who refinanced at rock-bottom rates. Data from the second quarter of 2022 shows that 92% of outstanding mortgages have rates below 6%, while nearly 83% have a rate below 5%. With the average 30-year fixed mortgage rate remaining higher, homeowners have a financial disincentive to sell their existing homes and buy new ones at higher rates. This rate lock-in effect reduces housing supply and makes it harder for homeowners to find a better home than their current one, resulting in fewer sales.

The average length of time someone lived in their home, or tenure, was approximately five years before the 2007 housing market crash. Between 2008 and 2016, average tenure increased to approximately eight years. By March 2023, tenure reached a historic high of 10.7 years. This increase in tenure suggests that many homeowners are reluctant to sell due to the financial implications of higher mortgage rates.

Although it is unlikely that mortgage rates will fall below 5% anytime soon, homeowner equity could help mitigate the impact of higher rates. National house prices increased over 40% from February 2020 to the peak in June 2022. Despite a subsequent decline of nearly 3%, the equity gained during the pandemic remains largely intact. High levels of home equity could help offset the rate lock-in effect, allowing sellers to make larger down payments on new homes and reducing the financial burden of higher rates.

For equity-rich homeowners or those relocating to more affordable areas, taking on a higher interest rate might not be a significant issue. Moreover, 42% of homeowners have no mortgage at all, freeing them from the lock-in effect. Despite these mitigating factors, the overall shortage of homes on the market continues to hamper home sales.

The current housing market can be likened to a game of musical chairs with a scarcity of chairs. The financial disincentives for sellers are likely to put a damper on any significant increase in housing supply this year. However, equity-rich and mortgage-free homeowners, as well as lifestyle considerations, could potentially counterbalance the impact of higher rates and breathe some life into the stagnant housing market.

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